Question 1

If the required reserve ratio is 10 percent and the Fed buys a $5,000 security from a depository institution, what happens to the money supply, using the simple multiplier?

Accepted Answer

The required reserve ratio is the percentage of deposits that banks must hold as reserves. If the required reserve ratio is 10 percent, then the simple multiplier is 1/0.1 = 10. This means that a $5,000 increase in reserves can support an increase in the money supply by a multiple of 10.

In this case, when the Fed buys a $5,000 security from a depository institution, the bank's reserves increase by $5,000. The bank can now lend out $45,000 ($50,000 - $5,000) of the $50,000 it previously had reserved. This $45,000 in new loans will be deposited in other banks, which will in turn lend out 90% of that, or $40,500. This process continues until the total increase in the money supply is ten times the initial increase in reserves, which is $50,000.

Therefore, the money supply will increase by $50,000.

Question 2

The money expansion process continues until there are no more

Accepted Answer

The money expansion process depends on banks having excess reserves that they can lend out. Once they have exhausted their excess reserves, they cannot make any more loans and the money expansion process stops. Option A is incorrect because even if there are no more required reserves, banks can still hold excess reserves that they can lend. Option B is incorrect because demand deposits are created during the money expansion process, not the other way around. Option D and E are incorrect because the presence or absence of liabilities or assets in the system does not directly affect the money expansion process.

Question 3

If a bank borrows $1,000 from the Fed and lends it out, the bank sets in motion a process that will result in an expansion of the money supply by a multiple of that $1,000.

Accepted Answer

This is because of the concept of the money multiplier, where banks are able to lend out a portion of the reserves they hold, which in turn becomes deposits in another bank, allowing for more lending and so on. This process continues until the money supply has expanded by a multiple of the original amount borrowed from the Fed.

Question 4

In order to increase the money supply, the banking system must have

Accepted Answer

In order to increase the money supply, the banking system must have excess reserves. Excess reserves are funds that a bank holds over and above its required reserves, which can be used to lend out money, leading to an increase in the money supply. The other options are not directly related to increasing the money supply.

Question 5

When the Fed buys U.S. government securities from a bank, that bank's excess reserves and required reserves increase but total reserves decrease.

Accepted Answer

When the Fed buys U.S. government securities from a bank, both the bank's excess reserves and required reserves increase, leading to an increase in total reserves.

Question 6

Money expansion stops when new reserves introduced into the banking system have been converted into

Accepted Answer

When new reserves are introduced into the banking system, banks are required to hold a certain percentage of those reserves as required reserves. Once the banks have fulfilled this requirement, any remaining reserves can be loaned out, resulting in a multiplication effect and expansion of the money supply. However, once all new reserves have been converted into required reserves, there is no further potential for money expansion.

Question 7

Exhibit 15-2
 
-Refer to Exhibit 15-2. By how much can this bank alone now increase its lending? Assume a required reserve ratio of 10 percent.

Accepted Answer

The answer of Exhibit 15-2
 
-Refer to Exhibit 15-2. By...

Question 8

Banks create new deposits by

Accepted Answer

Banks create new deposits by lending out excess reserves. When a bank receives a deposit, it is required to hold a portion of the deposit as reserves. The remaining portion can be lent out as loans to borrowers. When the loan is made, a new deposit is created for the borrower, which can be used to make purchases or payments. This increases the money supply in the economy. Banks can lend out more than their required reserves as long as they maintain a certain reserve ratio set by the central bank.

Question 9

In the money and credit expansion process, when r = the required reserve ratio, the total change in checkable deposits is equal to the initial change in excess reserves

Accepted Answer

The required reserve ratio represents the fraction of checkable deposits that banks must hold as reserves. So, if banks have excess reserves above the required amount, they can use those funds to create new loans and increase checkable deposits. The maximum amount that they can create is the initial change in excess reserves, divided by the required reserve ratio (1/r). Therefore, the total change in checkable deposits is equal to the initial change in excess reserves multiplied by 1/r.

Question 10

The simple money multiplier

Accepted Answer

The simple money multiplier equals the reciprocal of the required reserve ratio. This means that if the required reserve ratio is 10%, the simple money multiplier is 10, so if banks receive an additional $1 in reserves, they can lend out up to $10.

Question 11

What essential factor enables commercial banks to create money?

Accepted Answer

Excess reserves enable commercial banks to create money because they have more funds available to lend out than required by regulations. This enables them to create loans and, therefore, create new deposits, thus expanding the money supply. The other options (required reserves, state and local government securities, U.S. government securities, and net worth) do not directly enable commercial banks to create money.

Question 12

The banking system creates money in the sense that it

Accepted Answer

The banking system creates loans from excess reserves. This means that when a bank has excess reserves (reserves in excess of the required amount), it can use those reserves to make loans to borrowers. These loans increase the money supply since they create new deposits in the borrower's account, which can be used for spending or further lending by other banks. Therefore, the banking system creates money through the process of creating loans.

Question 13

When the Fed buys U.S. government securities from a bank, that bank's excess reserves and total reserves increase, but there is no change in required reserves.

Accepted Answer

When the Fed buys U.S. government securities from a bank, the bank's excess reserves and total reserves increase due to the increase in funds it received from the sale. However, the required reserve ratio remains the same, thus there is no change in required reserves.

Question 14

If the Fed purchases government securities on the open market, the money supply will

Accepted Answer

When the Fed purchases government securities on the open market, it pays for those securities with newly created money. The sellers (whether they are commercial banks or not) deposit that money into their bank accounts, increasing the reserves of those banks. This leads to an increase in the overall money supply through the process of multiple deposit creation by commercial banks. Therefore, the correct answer is E, which states that the money supply will increase through the commercial banking system regardless of who the seller is.

Question 15

If the required reserve ratio is 20 percent and the Fed buys a $10,000 security from a depository institution that currently has no excess reserves, what happens to the money supply, using the simple multiplier?

Accepted Answer

The answer of If the required reserve ratio is 20...

Question 16

Exhibit 15-1 
-Refer to Exhibit 15-1. If the interest rate on loans is 10 percent, the annual cost to Eubank of holding excess reserves is

Accepted Answer

The answer of Exhibit 15-1 
-Refer to Exhibit 15-1. If...

Question 17

When the Fed buys U.S. government securities from a bank, that bank's required reserves and total reserves increase but excess reserves decrease.

Accepted Answer

The answer of When the Fed buys U.S. government securities...

Question 18

Exhibit 15-2
 
-Refer to Exhibit 15-2. What kind of transaction just took place at Countybank?

Accepted Answer

Based on the transaction code TB4909_00, it indicates that $1,000 was deposited into a checking account.

Question 19

Which of the following would likely increase the money supply?

Accepted Answer

The answer of Which of the following would likely increase...

Question 20

When the Fed buys U.S. government securities from a member bank, that bank's excess reserves, required reserves, and total reserves all increase.

Accepted Answer

When the Fed buys U.S. government securities from a member bank, that bank's excess reserves increase, but its required reserves remain unchanged. Total reserves increase due to the increase in excess reserves.

Quiz 16: Banking and the Money Supply